Do You Have Momentum-itis?
by Mike VodickaMay 28, 2010 | Comments : 0 Recommended this article: (0)
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Are you more likely to buy the 52-week low than the 52-week high?
When a stock is up 50%, do you consider it too expensive?
Do you shy away from shares that have jumped higher on an earnings surprise?
If you answered yes to any of these questions, it's very possible that you are suffering from Momentum-itis, an acute psychological condition that prevents investors from buying great stocks that have been on a roll for fear of a pullback.
Any rational human being would understand and appreciate such fear; nobody likes buying an expensive ticket to an exclusive club only to see the party end early.
But without a good momentum move in your playbook, you are leaving one of the best and most reliable market-beating strategies on the table, because as Sir Isaac Newton espoused over 350 years ago, objects that are in motion tend to stay in motion.
What is Momentum?
The core strategy of momentum investing is to buy stocks that have been trending in one particular direction, frequently taking the form of buying a new high. Momentum investors aim to capture the waves of enthusiasm that can send stocks blasting higher for extended periods of time.
Sounds pretty simple, right?
Well, just because it's easy to explain doesn't mean it's easy to find. Successful momentum investing requires a special combination of both technical and fundamental analysis.
The first thing a momentum investor looks for is a nice, steady trend on the chart. That could be a series of new 52-week highs, a turn at a recent low or movement out of a consolidation pattern.
The momentum investor looks for some sort of technical catalyst that all the chart and system-driven investors of the world use to kick off a buying strategy. Throw in growing enthusiasm on the Street as the institutional players step into the game and start buying big blocks every $5 higher, and you're talking about a wall of demand to keep shares grinding higher.
This is exactly what we have seen happen with Apple (AAPL) over the last 18 months.
Since shares bottomed in March of 2009, it has been almost nothing but a straight shot higher, new 52-week high after new 52-week high. At the time, it may have been a bit intimidating to buy a series of new highs, but it's important to remember that there is a very good reason why shares of great companies are so hot: because they have the growth and earnings to back it up.
In this case, those who did step aboard the "amazing company express" were handsomely rewarded with market-beating returns and bragging rights amongst fellow investors. Take a look at the awesome trend in shares of Apple below.
The Definition of a Trend-AAPL
But a good trend is only half the story. That high flyer needs to be put through the fundamental gauntlet in order to qualify as a bona-fide momentum contender. The fundamentals help us figure out which stocks have the gas to finish the race.
In the world of fundamentals, there are few rivals to an earnings surprise when it comes to moving a share price. When an earnings surprise hits the Street, it's not uncommon to see shares skip large swaths of prices and literally jump higher as investors scramble to accumulate and analysts adjust their models. This is like pouring rocket fuel into the gas tank, with the power to initiate or help sustain an extended move.
An earnings surprise is great for a one-time power shot, but what happens when the music stops and someone flips the lights on? This is where earnings estimates come into play.
Let's take a second look at Apple. As the company's share price was rebounding last year, estimates began turning higher as well. This is a nod from the analysts that the company's business is rebounding, which helps to keep the valuation picture in check, a key ingredient for a sustainable trend. Take a look at Apple's rising estimates in the Zacks Estimates table below.
It's easy to see why Apple had such a great performance over the last year: It was a classic momentum stock. It had the right formation on the chart and it had the fundamental profile to support the story, posting an average earnings surprise of 40% over the last four quarters that kept estimates chugging higher the whole while.
How Do You Become a Momentum Investor?
But the story is not over. There will be plenty more momentum stocks in the future, and since you are now aware of your condition, you have two choices.
You can either self medicate or seek professional help. And since self medication is both dangerous and expensive, we recommend the latter.
We have a brand-new trading service called the Momentum Trader that uses all the bells and whistles of both technical and fundamental analysis to find the very best momentum stocks. A rigorous back testing analysis of the last 10 years, where we have experienced two horrific bear markets, shows that the Momentum Trader would have accumulated an annual gain of +35.9%, beating the pants off the S&P 500's -.05% loss over the same period. And those big gains actually came on less volatility than the overall market, with the Momentum Trader showing 23.5% less downside risk than the S&P 500.
Along with the buy/sell recommendations, I will also provide daily commentary on the market and how it affects the various positions in the portfolio. If you are interested in exploring momentum investing, now is the best time to look into this service. There are substantial Charter Member savings that end June 5.
Mike is an authority on momentum investing, and is Editor in Charge of the new Zacks Momentum Trader service.
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